Believe those who are seeking the truth. Doubt those who find it. Andre Gide

Thursday, June 19, 2014

How far are we from trend?

I am always amazed at how well a log-linear trend line seems to fits real GDP (or per capita GDP) in the United States. Through a great depression, sandwiched by two world wars, secular changes in the relative importance of different sectors (agriculture, manufacturing, services), the baby boom, the increase in female labor force participation, etc. Through it all, the U.S. economy just seems to revert to the same log-linear trend. Maybe it was just a fluke. Whatever the case may be, that trend seems to have broken down since the great recession. We've all seen the diagram (the red line in the graph below -- thanks to my colleague Fernando Martin for the nice pictures).

The red line above plots the real GDP per capita (log scale) since 1955. The trend line is calculated over the sample period 1955-2007. The average growth rate is 2.2% per annum. You can see the big "output gap" emerging in 2008.

But given what we know about U.S. demographics--in particular the large rise, then fall in labor force participation, is the red line really the best way to look at things? A rough way to control for demographics is to consider the real GDP as a ratio of the labor force, instead of population. That is what the blue line does above. Once again, the trend line is computed for the same period 1955-2007. The average growth rate here is 1.5% per annum. What this tells us is that a lot of our measured growth over this period was due to nonstationary labor force behavior, and not just productivity. Oh, and the output gap near the end of the sample is considerably smaller. (It is too small to the extent that the recent decline in the labor force is attributable to "discouraged workers" who plan to return once conditions improve.)

Here is the same analysis for Canada:

The average growth rates are 1.7% (red) and 0.9% (blue), per annum. The blue line suggests that the Canadian economy is right on trend.

I think it's instructive to compare the U.S. to Canada. Consider, for example, the employment-to-population ratio for males aged 25-54:

There is a modest secular decline in the employment ratio in both countries.The Canadian employment ratio is currently not too far from its historical average, while the U.S. number still has some way to go. Of course, the great recession hit the U.S. much harder than Canada. Canada's great recession began in 1990 and it took about a decade for that economy to recover.

If the Canadian experience through the 1990s (red line) serves as a guide, then employment growth in the U.S. (blue line) will remain in recovery mode for another 4 or 5 years. While much of the gap has already been filled (it is not as dramatic as the first diagram suggests), there is still a considerable way to go when one looks at employment (instead of unemployment). So perhaps we are closer, but not as close to our goals as Jim Bullard suggests here: A Tame Taper.

Two small related points: labor force participation is likely endogenous, and the recent trend in LFP may not be due to discouraged workers: http://soberlook.com/2014/06/recent-declines-in-labor-force.html

I think the "once conditions improve" comment is important. My understanding is that both short term unemployment and job openings are at normal (i.e. pre-GFC) levels. Five years into a recovery, what is the condition that has to improve before non-participants begin to search again?

Subscribe To

Favorite Quotations

"Believe those who are seeking the truth. Doubt those who find it." Andre Gide

The Democrats are the party that says government will make you smarter, taller, richer, and remove the crabgrass on your lawn. The Republicans are the party that says government doesn't work and then they get elected and prove it (P.J. O'Rourke)

But to manipulate men, to propel them toward goals which you – the social reformers – see, but they may not, is to deny their human essence, to treat them as objects without wills of their own, and therefore to degrade them (Isaiah Berlin)

I believe that sex is one of the most natural, wholesome things that money can buy (Steve Martin)

Nothing so needs reforming like other people's habits (Samuel Clemens)